Analysis of Financial Statements: Debt Management Ratios

Debt management ratios measure the extent to which a firm uses financial leverage and the degree of safety afforded to -Select-creditorsanalystsshareholdersItem 1 . They include the: (1) Debt-to-assets ratio, (2) Times interest earned ratio (TIE), and (3) EBITDA coverage ratio. The first ratio analyzes debt by looking at the firm's -Select-cashflow statementincome statementbalance sheetItem 2 , while the last two ratios analyze debt by looking at the firm's -Select-cashflow statementincome statementbalance sheetItem 3 . The debt-to-assets ratio measures the percentage of funds provided by -Select-debtholdersanalystsshareholdersItem 4 . Its equation is:

High debt ratios that exceed the industry average may make it costly for a firm to borrow additional funds without first raising more -Select-debtpreferred stockequityItem 5 . The times interest earned ratio measures the extent to which -Select-totaloperatingnetItem 6 income can decline before the firm is unable to meet its annual -Select-depreciationrentinterestItem 7 costs. Its equation is:

EBIT is used as the numerator because -Select-depreciationrentinterestItem 8 is paid with pre-tax dollars, the firm's ability to pay -Select-depreciationrentinterestItem 9 is not affected by taxes. The EBITDA coverage ratio is:

This ratio is more complete than the TIE ratio because it recognizes that depreciation and amortization are not -Select-deductiblecashrealItem 10 expenses, so these amounts are available to service debt, and lease payments and principal repayments are fixed payments.